Does Mandatory Disclosure Reduce the Cost of Capital? Evidence from Bonds

I examine whether the cost of debt is lower in states that have mandated the adoption of GAAP disclosure, compared to those with unregulated disclosure. I study municipal bond issuers because many states have unregulated disclosure, while others require GAAP, allowing an examination of the value of disclosure regulation in a relatively controlled experiment. Using a sample of municipal-level yield data, I find that mandatory disclosure is associated with a reduction of 15 basis points. Further, I find that the reduction in bond yields is the greatest among those organizations with relatively higher information asymmetry: those issuing unrated bonds, and small municipalities. In particular, unrated issues in GAAP states are associated with a yield reduction of 34 basis points, and small municipalities a yield reduction of 21 basis points. From this evidence, it is tempting to infer that municipalities benefit from mandatory disclosure, without consideration of the costs. However, prior research finds that the imposition of mandatory disclosure changes managers' use of alternate mechanisms, such as bond insurance, that also reduce the cost of debt. In further analysis, I find evidence consistent with regulation constraining the use of bond insurance among municipalities with relatively higher levels of information asymmetry. I conclude that disclosure regulation both provides benefits and imposes costs